Equity Share 20 million Stock price per share $40 Yield to maturity date 7.5% Bo
ID: 2680756 • Letter: E
Question
Equity Share 20 millionStock price per share $40
Yield to maturity date 7.5%
Book value of interest-bearing debt $320 million
Coupon interest rate on debt 4.8%
Market value of debt $290 million
Book value of equity $500 million
Cost of equity 14%
Tax rate 35%
If the company is contemplating what for the company is an average-risk investment costing $40 million and promising an annual after-tax cash flow of $6.4 million in perpetuity:
1)What is the internal rate of return?
2) What is the WACC?
3) If undertaken, would you expect this investment to benefit shareholders? Why or why not?
Explanation / Answer
1) for IRR, since this is a perpetuity NPV = cash flow / IRR IRR=cash flow/NPV=6.4/40=16% 2) for WACC Market value of equity=$40*20million=$800million Market value of debt=$290million Total firm value=800+290=1090million Cost of equity=14% Cost of debt=7.5% WACC=(800/1090)*(14%)+(290/1090)*(7.5%)(1-0.35)=11.57% 3)the project will benefit shareholders since its IRR>WACC
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